Saturday, August 27, 2011

Mongolians can learn from the Dutch

The story of the Netherlands is of relevance to Mongolia. How does a democracy with good institutions deal with the sudden discovery of mineral wealth? Initially, the Dutch followed a path which would later become known as the Dutch Disease: a strongly appreciating currency made the non-mineral sector uncompetitive, further aggravated by highly inflationary and unproductive government spending on wages and social transfers. Undoing the negative effects of the wage spiral and the overly generous social welfare system was painful and took more than a decade. The cure for the Dutch Disease was based on a voluntary, negotiated agreement between the same stakeholders which had been responsible for the Dutch Disease—government, labor and business. It was centered on conservative fiscal policies, including low public debt, and wage restraint. The essence of this agreement formed the basis of the subsequently highly successful Polder Model—a framework which also held up very well during the 2008 global financial crisis.

Mongolia has laid a strong legal foundation for a similar macroeconomic and fiscal framework in the three rules which form the basis of the Fiscal Stability Law passed with overwhelming majority in parliament in June 2010. The three rules put strict limits and ceilings on the fiscal deficit, expenditure increases and public debt. However, the essence of the FSL only kicks in 2013, when a structural fiscal deficit of no more than 2 percent of GDP needs to be adhered to. In the transition period, Mongolia would do well to heed the lessons from Holland: curing the Dutch Disease can be long and painful. Preventing the Dutch Disease to afflict the economy in the first place would be the wiser path to take, and, if the story of the Polder Model holds true, will also reward the politicians associated with this path.